Fool on Call: Microsoft's Office Party

The company is seeing a stronger-than-expected response to Office 2007, but is it enough to get excited over?

No one seems all that interested in Microsoft's (NASDAQ:MSFT)second-quarter results. Instead, investors are fixated on the software giant's upcoming third-quarter figures, since they will include $1.64 billion worth of Vista pre-orders that were removed from the second period.

Since everyone else is looking ahead, we'll be looking ahead as well, using this edition of Fool on Call to obtain a better perspective on the projected performance of key products. The discussion will revolve around these areas:

Vista and Office 2007

Xbox 360

Zune

Vista and Office 2007During the prepared-remarks portion of Microsoft's latest quarterly earnings conference call, management stuck to original guidance that called for 8% to 10% PC unit growth for the full year. The company continues to see the greatest increases in emerging markets of Asia and Latin America.

In the third quarter, however, this PC unit growth is expected to tick up slightly higher to around 9%-11%. It's no mystery why. Growth will accelerate in the second half of the year, "driven by broad availability of Windows Vista," CFO Chris Liddell said.

Where there has been a little upside surprise is in the launch of Microsoft Office 2007. Microsoft's business division is now expecting full-year revenue growth of 10% to 11%, which is two percentage points higher than the estimates it provided just a quarter ago.

One analyst did ask management during the question-and-answer session to comment on the very tight estimate ranges the company is employing and whether it's reasonable to think there could be more upside in Q3. While Liddell doesn't see Vista as having the kind of impact that Windows 95 had when it was unveiled more than a decade ago, he does admit that these estimates are an "appropriately conservative view of the second half [of the year]."

Given the positive press we've been hearing about the new Vista operating system, I think it's likely that at the end of the day, results will exceed management's narrow and conservative estimates. Whether Vista is a home run or not remains to be seen.

If ever there was a time that Microsoft needed a strong showing with its operating system, it's now. The personal computer environment is quite a bit different than it was in the Windows 98 and Windows XP days. Today, Apple(NASDAQ:AAPL) can no longer be brushed aside as a glorified supplier for schools and students. With the unveiling of the gorgeous, silky-smooth iMac now powered by Intel(NASDAQ:INTC), business at Apple stores has been brisk, leading to strong double-digit unit growth in both desktops and laptops.

Is Microsoft all that threatened by Apple's reemergence in the personal computing sector? Probably not, since Apple still enjoys only a very small part of the overall pie. However, with momentum clearly shifting, Microsoft needs a hit with its newest operating system more than ever before. We'll know soon enough just how big of one it has in Vista.

Xbox 360Where there's less mystery is in the performance of the Xbox 360 gaming console. In the most recent period, Microsoft's entertainment and devices division saw revenues increase a whopping 76%, in large part because of Xbox 360 sales.

To date, the company has sold 10.4 million of the consoles. Even more impressive, during the call, it was highlighted that U.S. consumers purchased "more Xbox 360s than both Nintendo Wii and Sony(NYSE:SNE) PlayStation 3 combined during the month of December." Much of that had to do with supply issues, of course, but it does show how the Xbox 360 benefited from its earlier release.

So, Xbox 360 sales are strong. Great news, right? Well, it is and it isn't. It isn't, because gross margins collapsed by 10 percentage points in the quarter compared to the same period a year ago -- because, with every 360 sale, the company actually loses money.

It is good news, though, in that strong console sales lead to better software and Xbox Live sales. The company saw a very favorable response to its Gears of War title, which sold 2.7 million copies in the first eight weeks of release. That means that more than one in four Xbox 360 owners went out and bought Gears of War. Additionally, almost half of all Xbox users are signed on to Xbox Live.

Because of the strong attach rates (sales to software, accessories, and Live), Microsoft is hopeful that the Xbox business will achieve profitability in 2008. It's particularly optimistic about 2008 because it's expected to be a banner year in terms of software titles.

ZuneI bet you were expecting me to report some exciting news on Microsoft's Zune, weren't you? Unfortunately, in the entire call, the only mention we got of the digital music and video player was this one-liner: "During the [second] quarter, we launched the Zune digital media in the United States, which furthers our strategy of connected entertainment."

Shareholders would certainly have liked more than that remark, especially since it seems certain that management would have reported on any surprisingly good news. We all know the Zune has an uphill climb if it wishes to challenge the iPod for dominance, so I'll just say this portion of the call was unsatisfying.

Cash is king...If it weren't for the enormous stash of cash that Microsoft has on hand, I'm quite convinced I would have no interest in this company. Of its three most exciting consumer-oriented products, we've got no reliable news on Zune; Xbox 360 is in a war of attrition; and Vista, no matter how cool, snappy, and user-friendly it ends up being, will still end up stuck in ugly PC desktop shells (although Microsoft operating systems can now run on Apple's beautiful machines).

Still, things are looking more positive for Microsoft than they were a year ago: Vista is receiving very positive reviews, and Xbox 360 has certainly held its own against intense competition. But in no way has this company found the kind of magic that Apple currently possesses. And until it finds it, it's hard for me to get excited about Mr. Softy.